Why, Yes, a Whole Lot of Companies Are Using Their Tax Cut Windfalls to Buy Back Stock

In this segment from the MarketFoolery podcast, host Chris Hill and Motley Fool Asset Management's Bill Barker reflect on a trend taking the corporate world by storm: In the first quarter, S&P 500 companies that have already reported bought back $150 billion of their own stock.

Now, some companies -- Apple (NASDAQ: AAPL), for example -- are producing so much cash that they can't deploy it in any other natural way. But is this really the best use of a tax giveback that was pitched as a move to promote corporate and economic growth? The guys put these share repurchases in historic and current context.

Chris Hill: For anyone who thinks we've been talking about stock buybacks more than we usually do, there's a reason for that. The Wall Street Journal reporting this morning that U.S. companies are buying back their own shares at a record pace. So far, S&P 500 companies that have reported earnings for the first three months of this year have bought back $150 billion worth of their own stock.

I'm curious what your take in general is on stock buybacks, because Buffett at the Berkshire Hathaway meeting over the past weekend, generally not a fan of it, although he seems to like the fact that Apple is going to be buying back stock. I'm sure the fact that Berkshire Hathaway owns a healthy chunk of that stock has everything to do with him applauding Apple for buying back shares.

Bill Barker: Well, they're buying the same thing he's buying, so, yeah, he has to applaud that. Apple just produces too much cash to really put it all to use. And unlike Berkshire Hathaway, where the central skill that the company has is capital allocation. Apple's central skill is not acquiring additional companies. So, buying back its own stock has worked pretty well. Historically, that's a better than average use of capital, and lower than average uses of capital are making acquisitions of companies other than your own.

So, on the whole, I think it's good. It's not surprising, given the tax cut. There's more cash. Apple brought back a lot of cash from abroad, wasn't able to put it to use there. Having brought it back, has to put it to use in some form. It's not surprising that it's stock buybacks. The tax cut in general is fueling a lot of this, as was predicted.

Hill: My own view on this is, it kind of depends on a number of things, including, what are the options that a company has for the cash. We were talking the other day about Starbucks and this deal with Nestle, this global marketing deal, and how Starbucks said they're going to take some healthy chunk, if not all, of the $7 billion they just got handed from Nestle, and they're going to put that toward share buybacks. As a longtime owner of Starbucks stock, I heard that news and I thought, good, because for all the success of Starbucks, they haven't really demonstrated a great ability to buy other companies, in particular food and beverage companies, and make them work. So, the fact that Starbucks is thinking, "Yeah, you know what? We're going to buy back our own stock," I've seen what happens when Starbucks goes out and acquires food companies, and I would much rather that they spend money buying back their own stock.

Barker: Yeah. For the most part, it's a better use of capital than acquiring other companies, as measured. Those who have taken the time to measure this have concluded that the stock buybacks historically have been a better use of cash. Now, historically, stocks have also been cheaper over the long spread of time than they're trading right now, perhaps. Most stock buybacks have come in the last couple of decades because of some changes in the tax laws, or changes in securities laws, which allowed companies more opportunity to buy back their own stock. So, it's more a function of the last two, three decades than the history of the market, where returning cash to shareholders, for the most part, came in the form of much higher dividends. You go back in time and you find that the larger history shows 4-5% annual return of dividends. That's no longer the case. It's less than 2%, it's been less than 2% for a while. But, buybacks are a bigger and bigger part.

Bill Barker owns shares of Apple. Chris Hill owns shares of Starbucks. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), and Starbucks. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Nestle. The Motley Fool has a disclosure policy.